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Welfare Implications of Capital Account Liberalization

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  • Ester Faia

    ()
    (Universitat Pompeu Fabra)

Abstract

In recent decades, capital account liberalization in emerging economies has often been followed by a surge in capital inflows, despite the presence of severe informational asymmetries for foreign lenders. Empirical studies have shown that in emerging economies financial liberalization has led to an increase in consumption volatility (also relative to output). I use a small open economy model where foreign lending to households is constrained by an endogenous borrowing limit. Borrowing is secured by collateral in the form of durable investment whose accumulation is subject to adjustment costs. This economy is able to replicate the aforementioned stylized fact in response to various shocks (productivity, foreign demand and government expenditure). I find that financial liberalization reduces welfare since it increases the volatility of consumption and employment.

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Bibliographic Info

Paper provided by Tor Vergata University, CEIS in its series CEIS Research Paper with number 92.

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Length: 26
Date of creation: 20 Feb 2007
Date of revision:
Handle: RePEc:rtv:ceisrp:92

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Postal: CEIS - Centre for Economic and International Studies - Faculty of Economics - University of Rome "Tor Vergata" - Via Columbia, 2 00133 Roma
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Keywords: endogenous borrowing limit; financial liberalization; consumption volatility.;

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Cited by:
  1. Massimiliano Pisani, 2011. "Financial Openness and Macroeconomic Instability in Emerging Market Economies," Open Economies Review, Springer, vol. 22(3), pages 501-532, July.

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